Aside from the crappy grammar, what bothers you most about this statement.
-Source, ex real estate coworker of mine who thinks I’m just some dumb brotha. This coworker does not have an MBA or CFA.
Well, REITs have been doing really well of late. But up 20% since October is clearly not a sustainable rate of growth when housing prices are flat or still trending downward.
I’ll admit, I’m a real estate hater when it comes to tangible property. I have my fair share of REITs in my PA. My coworker was ranting how I ain’t right since I don’t own real estate and how renting is 100% waste of money.
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First most single family homes are assets at best. They are not investments.
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That tax decuction of interst is a sham. Whooptie do, you save a few bucks on your income taxes. Last time I checked, tax implications was about the worst investment strategy. I’d love to pay $1M a year in taxes for long term realized gains.
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I am a mobile guy. I like to move here and there at the drop of a hat. I honestly don’t have a ‘home’ when I think of my past. I moved around while growing up and that trend still remains in my elder years now. I don’t plan on settling anytime soon. Therefore renting with few possessions is how I roll.
My coworker is a redneck conservitave pseudo racist sumbitch who think po folks like me need their wordz of wizdum. I may have to go street on his azz.
Buying real estate is “conventional wisdom” among US people. It’s one of the things that contributed to the housing bubble.
However, for most people, locking most of your money in an illiquid asset might not be a bad idea. Even if their investment fails to appreciate in value, it prevents people from squandering their savings on iPods and trampolines. Imagine what would happen if all these credit-crazy US consumers didn’t have houses for the banks to grab. Instead of widespread foreclosures, we would have widespread personal bankruptcies.
I believe that in the current economical environment buying real estate is a good solution:
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obviously, paying rent doesn’t have any wealth building component, unlike paying down a mortgage.
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now is the proper time to get in debt (at reasonable levels of course) at a fixed rate: inflation can only climb in the years to come with the current printing press. Conversily, now is a terrible time to be investing in fixed income.
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if you don’t live in it, you can deduct the interests on your loan. I don’t see how Cfavsmba can claim that this is for the birds. IMO, this is a major argument.
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in reasonable environments, and I am not talking subprime America, but rather like european capitals, RE is an extremely safe asset class.
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inflation hedge : both capital gains and rent income indexation.
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“real asset”: again, I am 100% into owning real assets in the current environment. Like I said, forget FI, and I fear for equities. That’s right : I am super paranoid about the cocktail of global trade imbalances between USA and China+China RE bubble+USD vs Yuan+USD Debt. I am afraid we’ll see some major crashes in the next 10 years.
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all in all, I think it is the “less worse” asset class at the moment for retail investors.
Of course…it’s boring as fuck to have your egg nest tied in RE. It’s way more fun to trade options or to come to AF to say that you’ve made 15% in 2 months on XYZ.
What do you guys think ?
I think most of the points you make are not invalid. However, if you run the numbers, there are a bunch of hidden costs and downsides that make real estate less appealing. I can think of a few below. Empirical data shows that over the long run, equities have outperformed real estate once you consider the additional costs (although, the future might not necessarily look like the past).
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Opportunity cost of your downpayment.
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Despite the tax deduction, you still pay interest on the mortgage.
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Illquidity - if you want to live in the house for 20 years, then this is not a problem. However, if you want to sell in say, 5 years, then you need to consider the bid/ask, broker fees and closing costs.
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Safeness of investment is questionable. Where’s the evidence to show that real estate is safer than a diversified portfolio of liquid investments?
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You can get inflation hedging through other ways, like buying commodities.
Owning a home that you live in is often a good financial decision, except when purchased at the top of a bubble. It is nice when money you have to pay actually goes into building an asset, as opposed to just going out the door.
The interest deduction for taxes is nice, but not a huge differentiator. The main reason to think about it is that if you are comparing mortgage payments to equivalent rents, you want to remember that you get some of those mortgage payments back later on in lower taxes. So the tax issue is really only significant when making rent vs mortgage payment comparisions. The other thing about mortgage interest deductions is that it often pays enough so that it starts making sense to itemize other deductions instead of just taking the standard deductions, and that can translate to an extra few hundred or even a thousand or two in taxes avoided.
Viceroy has some good arguments here. I’m not on the market for real estate, but I am not so sour on it as I once was.
I believe that in the current economical environment buying real estate is a good solution:
- obviously, paying rent doesn’t have any wealth building component, unlike paying down a mortgage.
*I rent cheap and invest the difference. I could not get a mortgage payment for the cost of my rent. Also, I assume no risk of repairs, upkeep, and property valuation. That’s for the landlord to assume. My rent could rise, but I doubt this will be the case as this is a more of a handshake arrangement versus a fixed lease contract.*
- now is the proper time to get in debt (at reasonable levels of course) at a fixed rate: inflation can only climb in the years to come with the current printing press. Conversily, now is a terrible time to be investing in fixed income.
*True. If I were to live somewhere for a long time, I would buy something. But given I don’t plan on sticking around anywhere for any length of time, I feel the cost/stress of buying and selling my home would outweigh that of cheap rent.*
- if you don’t live in it, you can deduct the interests on your loan. I don’t see how Cfavsmba can claim that this is for the birds. IMO, this is a major argument.
*True. So you pay $100 a month in interst. You’re tax rate is 30%. You’re saving $30 in tax savings. What about the $70 in AT interest you still pay? Far too many people think the interest deduction is more of a holy grail than it is. Let’s not forget AMT kicks in for most people too if this deduction is too high.*
- in reasonable environments, and I am not talking subprime America, but rather like european capitals, RE is an extremely safe asset class.
*Safe asset class yes. It is not an appreciation or income return based asset class for most people.*
- inflation hedge : both capital gains and rent income indexation.
*Inflation hedge. Kinda. Though tradable real assets like soybeans, gold, oil, etc are probably better since they are marked to market in varioius exchanges. RE appraisals are very subjective and costly.*
- “real asset”: again, I am 100% into owning real assets in the current environment. Like I said, forget FI, and I fear for equities. That’s right : I am super paranoid about the cocktail of global trade imbalances between USA and China+China RE bubble+USD vs Yuan+USD Debt. I am afraid we’ll see some major crashes in the next 10 years.
*Perhaps, perhaps not. I diversify for this reason.*
- all in all, I think it is the “less worse” asset class at the moment for retail investors.
*I agree. But that does not make it a infallible asset class like my coworker was describing.*
So part of your mortgage is interest and doesn’t build wealth in any way. But all of your rent goes somewhere that doesn’t build wealth. You still need a place to live either way. If you’re talking about paying $1500/month in rent or $1500 in mortgage payments, then - assuming the initial mortgage is 10% principal and 90% interest - you are still building $150 per month in asset wealth (really liability reduction), and paying $1350 in interest. Then you get back 28% of the interest at tax time, so you are basically investing $150 in real estate (admittedly a risky asset) and paying $972 net interest (interest paid minus tax reduction).
So I’d rather live in a place for $972 per month plus $150 call option on the capital growth, or $1122 total, versus living in the same place and pay $1500 rent and no call option. The difference is $378 per month.
If you think other asset classes are going to appreciate faster than real estate over your time horizon, then the opportunity cost of the down payment is a real consideration.
I still think the calculation is very different for a primary home vs. a second home or property that you intend to rent as a landlord.
The other issue is how much of one’s wealth is tied up in real estate. The argument that real estate may be a sensible asset class now (ordinary rates of return, vs the bubble growth of the 2000s) seems like a good one. However, it may still be too risky to have 75 or 80% of your net worth tied to it, the way it often is for middle class families. From an investment standpoint, the asset can be good, but you wouldn’t want to have it be 60%+ of your portfolio.
Why do you have a call option on capital growth? Real estate can also depreciate in value.
Why would you invest in an expensive illiquid asset, pretty sensitive to the economy, and hard to value unless you have a lot of specialized knowledge or substantial capital to risk? I’d think you’d be better off going with other hard to value assets like gold or fine wines.
I think a house should only be viewed as a place to live rather than an investment, no diff from owning a car.
You are adding $150 of equity into the home. If the home value declines by more than $150, you walk away from your mortgage and the home, and are out $150. If the home value goes up, you keep the equity. That isn’t a 1-to-1 equivalence to a call option, because future months also contribute capital, but it’s pretty similar.
Another way to look at is is with Put-Call Parity: The mortgage has an embedded put option in it (just walk away from the house).
Asset (Home) + Put Option (in Mortgage) - Cash (Mortgage Liability) = Call Option
^Let’s not give the average Joe any ideas. Next thing you know home owners will become rational and walk away once the home value is .01 less then the equity.
Ok, I thought this might be what you meant. The problem is that it is not costless to walk away from your mortgage, since your credit will be adversely affected. Also, there will be collateral damage, i.e. your foreclosed house gets sold at discount, thus lowering the estimated home value of neighboring houses (if you care about that, anyway).
Yeah, it’s not a perfect call option, or maybe it’s just more expensive than $150 if it expires worthless, but it is also highly leveraged, which can make it attractive despite the costs. People have survived foreclosure better than people have survived without any shelter at all.
Obviously, there are a lot of variables to consider, and I think the big one for most people is just that a home is typically their largest single asset, and that the risk of having that much of a person’s net worth subject to the real estate market makes it hard to advocate the original statement “if you ain’t in real estate, you ain’t doin somfin right.”
its a simple calculation with added utlility for owning your home and therefore the outcome will not be the same for everybody…its not rocket science…you guys are making a simple matter more difficult than it should be…
Palantir, are you being sarcastic about wine and gold and cars?
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I fail to see how wine isn’t a high risk asset
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Gold has increased 60% p.a. on average in the last 10 years. I’m not saying it is a bubble, but there is a huge risk that it is.
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Both wine & gold have insurance storage and other associated costs with no current income
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A car is nothing like a home. In fact, a car is a guaranteed loss, from an investment perspective
It depends on which state you live in. There are states where a lender cannot go after you after a foreclosure for any remaining unpaid debt. E.g. Texas
In some states, you can live in the house until the foreclosure (free). E.g. FL
Bchadwick, I don’t think that it is at all like a call option, if personal bankruptcy is taken into the equation. In fact, it is nothing like an “option”, since there is nothing to “exercise” here. You walk away from mortgage, you are bankrupt.
I live in continental Europe, where bankruptcy law is pretty harsh. In fact, being bankrupt here makes your life a bitch.
For example, I believe that you are forbidden to work in financial services if you were once bankrupt.
You can be foreclosed on without being bankrupt, at least here in the US. If bankruptcy is the alternative to meeting the mortgage payments, then - although I maintain it is still an option - the option is pretty unattractive.
In any case, the option part of my argument was really not the main point, somehow it seemed to become one. The option was more of an interesting observation, and in my original post, I did say that 1) real estate is a risky asset, not appropriate for everyone, and 2) even if you think real estate has bottomed or is attractively priced for your time horizon, you can still have too much exposure to it.
And yes, this was written with a US audience in mind. I wasn’t aware that there was a mortgage interest deduction in Europe (since I’m not professionally in real estate and have never bought a place there).